From Europe to the Euro

Erica EdwardsCenter for European StudiesUniversity of North Carolina at Chapel Hill

Plan of Attack

• Stewart and Colbert on the Euro

• Quiz – The Nuts of Bolts of the Euro

• National preferences and international institutions – negotiating the Maastricht Treaty and EMU

• Transitioning to the Euro

• Q&A

Nuts and Bolts of the EuroA quiz

1. What was the start date of Economic and Monetary Union?a) Jan 1980 The first major monetary policy initiative (1970 Werner Plan) called for EMU by Jan 1980, but adverse economic conditions doomed the

initiative.

b) Jan 1999Correct. EMU officially started on Jan 1,1999. Conversion rates were irrevocablyfixed and legislation related to

introduction of the euro came into force.

c) Jan 2002Circulation of euro banknotes began.

2. How many countries are currently in the euro area?

a) 27 Number of current EU member states.

b) 11Number of countries that originally joined in 1999.

c) 16Correct. As of 2009, 16 EU member states are part of the euro area

•

1999 Belgium, Ireland, Spain, France, Luxembourg, the Netherlands, Austria, Portugal, Finland

2001 Greece

2007 Slovenia

2008 Cyprus, Malta

2009 Slovakia

The “Outs”• Britain, Denmark, Sweden,

and most of Eastern Europe remain outside of euro

• To join would need popular support and low budget deficits

• Britain and Sweden unlikely to join unless economy tanks

• Eastern European countries perhaps more likely to join as they meet criteria

3. What were the set of rules set out for entry into the European Monetary Union?

a)Copenhagen Criteria The political, economic, and legislative

requirementsthat countries must meet to join the EU.

b) Stability and Growth PactPact enacted in 1997 to ensure that fiscal disciplinewould be maintained and enforced in the EMU.

c) Convergence CriteriaCorrect. The 1992 Maastricht Treaty set out 5 criteria that countries needed to meet prior to joining the EMU.

The So-Called “Maastricht Criteria”Inflation rates: No more than 1.5 percentage points higher

than the average of the 3 best performing (lowest inflation) member states of the EU.

Government finance:• Annual government deficit: Ratio of the annual

government deficit to GDP must not exceed 3% at the end of the preceding fiscal year.

• Government debt: Ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year.

Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devalued its currency during the period.

Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the 3 lowest inflation member states.

4. Who sets interest rates in the EMU?a) The European CouncilDetermines membership in the eurozone.

b) Member States Manage national fiscal policies within EU limits. .c) The European Central BankCorrect. ECB controls interest rates for euro. Independent of political authorities; goal is low inflation.

d) The European ParliamentNot important here.

The European Central Bank

• Established under the Amsterdam Treaty (1998)

• Modeled after the German Bundesbank

• Headquartered in Frankfurt• Current president Jean-Claude Trichet• The primary objective of the ECB is to

maintain price stability within the Eurozone, or in other words to keep inflation low!!

5. What is the current dollar-euro exchange rate?

a)86 centsJanuary 2002

b) $1.59 July 2008 .

c) $1.27Correct.

National preferences & international institutions

Negotiating the Maastricht Treaty

Why would governments agree to abandon their national currencies, and thus their ability to implement an autonomous monetary policy, in favor

of a single currency?

Answer: the benefits outweighed the costs

Benefits of Monetary UnionBenefits of a single currency include:• Promote trade and investment• Eliminates competitive devaluations• Tied Germany to west after

unification• Insulates EU from rest of world• Locks in objectives of low inflation

and smaller budget deficits

Costs of Monetary Union

Countries joining monetary union must:

• Agree to share authority over interest rates, the single most important tool of economic policy

• Give up ability to devalue currency• Agree to EU limits on overall fiscal

policy stance (i.e. limit budget deficits)

A Single Currency - Competing Models

Technocratic• Priority of monetary

integration should be to maintain low inflation.

• Authority over monetary policy should be invested in a political independent central bank directed to keep inflation low.

• EU should have strict rules limiting size of budget deficits.

Politicized • Priority of monetary

integration should be to promote growth and employment.

• Governments need to coordinate all tools of economic policy – fiscal, monetary, exchange rate – to achieve these goals.

And the winner is….

Outcomes of negotiations for the MaastrichtTreaty favored the technocratic German view:• Politically independent ECB tasked with

keeping inflation low• Convergence criteria• Only Britain and Denmark allowed not to

participate (French victory)• Deadline for creation of single currency

(small victory for the French)

Why did Maastricht So Closely Match German Preferences?

Two possible explanations:

• Idea Diffusion

• Domestic Politics & Bargaining Power

Transition to Monetary Union

Rough Seas or Smooth Sailing?

The backlash begins…The backlash begins…

• 1992/93 marks end of public’s “permissive consensus”

• European project finally starts to hit home for citizens (i.e. touches their daily lives)

react by objecting to technocratic, elite- driven nature of integration process

• Ratification problems:– the Danish “no”– the French “petit oui”– German constitutional woes

Joining the Euro

• As late as 1995, only 3 countries had met the convergence criteria:

Ireland, Luxembourg, Finland

• In 1998 decided that all countries wanting to join passed muster…with the exception of Greece.

How did countries like Italy, Belgium, France, Germany meet the most important fiscal criteria?• Cheating• Large-scale privatization to increase

income• Italy introduced a “euro tax”• Fear of exclusion from euro to gain

domestic political support for cuts• Pro-European government in Italy with

supports that wanted to reduce deficits• France ran a deficit of 3.07% of GDP and

dared anyone to keep them out!

Designing the Euro Sign

“Inspiration for the € symbol itself came from the Greek epsilon (Є)– a reference to the cradle of European civilization – and the first letter of the word Europe, crossed by two parallel lines to ‘certify’ the stability of the euro.”

– European Commission

Designing the Currency

Designing the Currency